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The U.S. Supreme Court ruled on Monday that farmers who sold farm
assets during a bankruptcy reorganization under Chapter 12 of the
Bankruptcy Code were liable for the full amount of the capital gains
tax that resulted from the sale (Hall, Sup.
Ct. Dkt. No. 10-875 (U.S. 5/14/12), aff’g 617 F.3d 1161 (9th
Cir. 2010)).

In an opinion that affirmed a Ninth Circuit decision and resolved a
split in the circuits, a divided Supreme Court (in an opinion by
Justice Sonia Sotomayor joined by Chief Justice John Roberts and
Justices Samuel Alito, Clarence Thomas, and Antonin Scalia) held that
federal income tax liability resulting from the farmers’ post-petition
farm sale is not “incurred by the [bankruptcy] estate” under Section
503(b) of the Bankruptcy Code and therefore not dischargeable in a
Chapter 12 bankruptcy.

Chapter 12 of the Bankruptcy Code, which governs farm bankruptcies,
allows farmer debtors to enter into a reorganization plan. The plan
must provide for full payment of “priority claims,” but certain
government claims, including “any tax . . . incurred by the
[bankruptcy] estate” are downgraded to general, unsecured claims that
are dischargeable without full payment (Bankruptcy Code §§503(b),
507(a)(2)).

The farmers in the case filed for Chapter 12 bankruptcy and then
sold their farm. The IRS attempted to collect capital gains tax on the
proceeds of the sale, but the farmers proposed to treat the tax as an
unsecured claim that would be paid to the extent funds were available
and the unpaid balance discharged. The case moved through Bankruptcy
Court, federal district court, and then to the Ninth Circuit, which
held that because a Chapter 12 bankruptcy estate is not a separate
taxable entity under Secs. 1398 or 1399, the estate does not “incur”
post-petition federal taxes. Because the tax was not “incurred by the
estate” as required by Bankruptcy Code Section 503(b), the Ninth
Circuit held that it was not eligible for discharge.

The Supreme Court’s majority agreed that “the statute’s plain
language, context, and structure” support this conclusion and upheld
the Ninth Circuit’s decision.

In a dissenting opinion, Justice Stephen Breyer, joined by Justices
Anthony Kennedy, Ruth Bader Ginsburg, and Elena Kagan, argued that the
farm bankruptcy provisions had been amended specifically to avoid the
result reached in the case. Sen. Chuck Grassley, R.-Iowa, had
sponsored the amendments to these provisions to enable farmers to
qualify for Chapter 12 who might have to sell property held for a long
time that had a low basis and thus would not be able to qualify if the
taxes on the sale of the property were nondischargeable. The amendment
was intended to place taxes incurred after the bankruptcy petition was
filed in the same position as other unsecured creditors.

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